Fiscal Policy Wrap-up Multiplier Effect, Policy Lag & Automatic Stabilizers.

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Presentation transcript:

Fiscal Policy Wrap-up Multiplier Effect, Policy Lag & Automatic Stabilizers

Fiscal Policy Lag & End Result All fiscal policy has long “policy lags” –Changes in Taxes & Gov’t Spending take time to occur The end result of expansionary fiscal policy on AD & Real GDP is difficult to forecast –Tax cuts & ↑ Gov’t Spending => push AD to the right –While other factors => push AD to the left –The “exact” end result is uncertain

Opposing forces of Fiscal Policy? Multiplier Effect (helps) Automatic Stabilizers (helps) Crowding Out (hurts) Net Export Effect (hurts) State & Local Tax Laws (hurts) These 3 opposing forces make predicting final effect of FISCAL POLICY Difficult! AD 2 Make fiscal policy more effective Make fiscal policy less effective

Multiplier Effect Crowding Out When Government Spending increases or Taxes are cut: → Multiplier argues for a larger increase in real GDP (AD) → Crowding out argues for a smaller increase in AD (real GDP) The CONFLICT between 2-theories : We ASSUME the multiplier always overpowers crowding out! (AD shifts right!)

Automatic Stabilizers Considered anything which automatically: –Increases deficit during recessionary periods –Increases surplus during inflationary periods During Recessions Gov’t collects less taxes Pays more unemployment & welfare benefits, food stamps, (transfer payments) During Booms Collects more taxes (progressive tax system) Pays less unemployment & welfare benefits, food stamps, (transfer payments)

Net Export Effect Gov’t Borrows more $ Currency Appreciates $ Export Less Real Interest Rates Rise Explanation: Expansionary fiscal policy => leads to crowding out The US $ appreciates –Goods become more expensive for foreigners They buy less (NX ↓)

State & Local Taxes States & Local Governments are required to balance budget –California was in a budget crisis in 2010! Proposition 30 helped Deficits can only exist in short run! Therefore, states often raise taxes as federal government cuts taxes –This partially offsets expansionary fiscal policy

Practice Free Response

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